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Index Providers React to Russian Market Turmoil

Index providers and asset managers are writing off Russia.

On March 2, index providers MSCI and FTSE Russell announced they would delete Russian stocks from their mainline benchmarks, writing their prices down to zero in the process. They said the country's securities are no longer investable. The Moscow Exchange is closed, and London and New York exchanges have halted trading of listed depositary receipts of Russian firms. If index providers' clients can't trade the stocks, they don't want them in the index. As I see it, the message is as strong as an index manufacturer can send from its perch, effectively: "You're on your own now, and your stock market is worthless." What comes next is anyone's guess, but the immediate impact on index exchange-traded and mutual funds with exposure to Russian stocks is increasingly clear.

Assessing the Impact

Per Morningstar Direct, there were 150 index-tracking ETFs and mutual funds with more than 0.5% of their portfolio invested in Russian equities as of Dec. 31, 2021. The combined value of these funds’ Russian stock holdings totaled nearly $17.5 billion, representing 1.9% of their total assets. As of the end of February 2022, the value of these funds’ positions in Russian stocks had fallen more than 77%, to just below $4 billion, representing 0.5% of their assets.

In the coming days, it is likely that these funds’ sponsors will write the value of many of these stocks down to zero. We’ve already seen some move to make these marks. On March 3, BlackRock marked the values for its Russian stock holdings that had stopped trading to zero. The March 4 per share net asset value for the iShares MSCI Russia ETF ERUS was $0.06--down 94% from $0.93 on March 2. On March 4, Amundi, Europe’s largest asset manager, announced that it would also begin marking the value of its funds’ Russian holdings to zero until further notice.

The impact of a write-off of Russian stocks on most investors’ portfolios is likely negligible. Using the Morningstar Global Markets Index as a proxy for a diversified equity portfolio, Russian stocks--at market weight--represented just 0.21% of a 60/40 stock/bond portfolio as of Dec. 31, 2021. Most investors’ exposure was likely lower still.

But some funds and some investors will take a bigger hit than others. Exhibit 1 shows the 10 funds that had the largest exposures to Russian stocks as of Feb. 28, 2022.

No indexed stock funds will be as negatively impacted as the five ETFs offering pure exposure to Russian stocks: VanEck Russia ETF RSX, iShares MSCI Russia ETF, VanEck Russia Small-Cap ETF RSXJ, Franklin FTSE Russia ETF FLRU, and Direxion Daily Russia Bull 2X ETF RUSL. The Direxion fund's fate is already sealed. While it never owned any Russian stocks directly (it got exposure via a total return swap), the firm will liquidate it on March 18. The story for the remaining four is more complicated.

All Bets Are Off

The remaining four Russia-focused ETFs have stopped accepting new money from investors, suspending the creation of new shares. That hadn't stopped market participants from using them to speculate, however. RSX and ERUS experienced record trading volumes during the week of Feb. 28. But on March 4, the New York Stock Exchange halted trading in ERUS, FLRU and RUSL. Shortly thereafter, CBOE announced it would suspend trading in RSX and RSXJ.

Stuck for Now

For the time being, anyone who owns shares of ERUS, FLRU, RSX, or RSXJ is stuck with them. The same goes for any fund that owns Russian stocks or their associated depositary receipts. The Moscow Exchange is closed, and trading of depositary receipts has been halted on all exchanges outside Russia.

I expect more asset managers will follow BlackRock’s and Amundi’s lead--marking their Russian holdings down to zero. This helps them to manage their index portfolios to the extent that will resolve potential tracking error issues once the securities have been removed from these funds’ benchmarks. It may also help them to comply with rules regarding the portion of their portfolios that are invested in illiquid assets. Deeming these assets to be worthless can keep them in compliance.

These measures will impact some sizable funds. Exhibit 2 features the 10 largest funds among the 150 index-tracking ETFs and mutual funds that had more than 0.5% of their portfolios invested in Russian equites as of Dec. 31, 2021.

What Comes Next?

There is no way of knowing what comes next. At one extreme, these stocks could be permanently impaired. Foreign owners could have their rights revoked and lose everything. At the opposite extreme, Russian equities and depositary receipts might resume trading and be brought back into mainline indexes.

In the event that trading resumes, it is likely that index providers and asset managers would revisit the decisions and the marks that they’ve made in recent days. For now, investors have been served with a poignant example of the risks of investing in an autocratic state.

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